UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR QUARTER ENDED MARCH 31, 1998 Commission File Number 0-10248 FONAR CORPORATION - ------------------------------------------------------------------------ (Exact name of registrant as specified in its charter) DELAWARE 11-2464137 -------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 110 Marcus Drive Melville, New York 11747 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (516) 694-2929 --------------------------------------------------- Registrant's telephone number, including area code: Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ---- ---- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the close of the period covered by this report. Class Outstanding at March 31, 1998 - -------------------------------- --------------------------------------- Common Stock, par value $.0001 50,221,305 Class B Common Stock, par value $.0001 5,411 Class C Common Stock, par value $.0001 9,562,824 Class A Preferred Stock, par value $.0001 7,855,627
FONAR CORPORATION AND SUBSIDIARIES INDEX PART I - FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets - March 31, 1998 and June 30, 1997 Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 1998 and March 31, 1997 Condensed Consolidated Statements of Operations for the Nine Months Ended March 31, 1998 and March 31, 1997 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 1998 and March 31, 1997 Notes to Condensed Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations PART II - OTHER INFORMATION
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (000's OMITTED) ASSETS March 31, June 30, 1998 1997 (UNAUDITED) Current Assets: --------- ------- Cash and cash equivalents $ 64,762 $ 5,861 Receivable from litigation award - 77,223 Accounts receivable - net 10,269 6,000 Costs and estimated earnings in excess of billings on uncompleted contracts 1,117 819 Inventories 4,088 3,441 Prepaid expenses and other current assets 288 410 ------ ------ Total current assets 80,524 93,754 ------ ------ Property and equipment - net 7,820 6,068 Advances and notes to affiliates and related parties- net 891 1,929 Long-term accounts receivable - net 254 254 Notes receivable - net 32 107 Capitalized software development costs - net 506 772 Other intangible assets - net 14,115 3,569 Other assets 715 238 -------- -------- $104,857 $106,691 ======== ======== See accompanying notes to consolidated financial statements (unaudited).
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (000's OMITTED) March 31, June 30, LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997 (UNAUDITED) Current Liabilities: ---------- -------- Notes payable $ 424 $ 415 Current maturities of long-term debt and capital lease obligations 1,999 2,388 Accounts payable 1,176 2,837 Other current liabilities 11,498 13,471 Dividends payable 7,855 7,855 Customer advances 303 764 Billings in excess of costs and estimated earnings on uncompleted contracts - 193 Income taxes payable 2,950 100 Deferred income taxes 222 3,072 ------ ------ Total current liabilities 26,427 31,095 Deferred income taxes, net of current portion 222 222 Long-term debt and capital lease obligations less current portion 9,175 1,824 Other non-current liabilities - 101 ------ ------ Total liabilities 35,824 33,242 ------ ------ Minority interest 92 204 ------ ------ Commitments and contingencies - - STOCKHOLDERS' EQUITY Common Stock $.0001 par value; 60,000,000 shares authorized; 50,221,305 issued and outstanding at March 31 and 49,133,422 at June 30 5 5 Class B Common Stock $ .0001 par value; 4,000,000 shares authorized, (10 votes per share), 5,411 issued and outstanding at March 31 and at June 30 - - Class C Common Stock $.0001 par value; 10,000,000 shares authorized, (25 votes per share), 9,562,824 issued and outstanding at March 31 and at June 30 1 1 Class A non-voting Preferred Stock $.0001 par value; 8,000,000 authorized, 7,855,627 issued and outstanding at March 31 and at June 30, 1997 1 1 Paid-in capital in excess of par value 93,720 90,640 Accumulated deficit (21,982) (13,992) Notes receivable - stockholders ( 2,135) ( 1,919) Unearned compensation ( 274) ( 1,096) Treasury stock - 108,864 shares of common stock at March 31 and at June 30 ( 395) ( 395) ------- ------- Total stockholders' equity 68,941 73,245 ------- ------- Total liabilities and stockholders' equity $104,857 $106,691 ======= ======= See accompanying notes to consolidated financial statements (unaudited).
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (000's OMITTED, except per share data) FOR THE THREE MONTHS ENDED MARCH 31, --------------------- 1998 1997 REVENUES -------- -------- Product sales - net $ 1,232 $ 1,204 Service and repair fees - net 657 699 Scanning and management fees - net 5,247 2,539 -------- -------- Total Revenues - Net 7,136 4,442 -------- -------- COSTS AND EXPENSES: Cost of product sales 1,880 2,070 Cost of service and repair fees 614 572 Cost of scanning and management fees - net 3,415 1,621 Research and development expenses 1,936 1,977 Selling, general and administrative expenses 3,215 3,184 Provision for bad debt 150 520 Compensatory element of stock issuances 274 138 Amortization of excess of cost over assets acquired 35 - ------- ------- Total Costs and Expenses 11,519 10,082 -------- -------- Loss From Operations ( 4,383) ( 5,640) Interest Expense ( 99) ( 81) Interest Income 839 101 Other income-principally gain on litigation awards 3 - ------ ------- Income (loss) before provision for taxes and minority interest ( 3,640) ( 5,620) Provision for income taxes - - ------- ------- Income (loss) before minority interest ( 3,640) ( 5,620) Minority interest in net (income) loss of subsidiary and partnership ( 29) 55 ------- ------- NET INCOME (LOSS) $( 3,669) $( 5,565) ======= ======= Net Income (Loss) per share $(.06) $(.09) ====== ====== Weighted average number of shares outstanding 61,120 58,693 ====== ====== See accompanying notes to consolidated financial statements (unaudited).
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (000's OMITTED, except per share data) FOR THE NINE MONTHS ENDED MARCH 31, --------------------- 1998 1997 REVENUES -------- -------- Product sales - net $ 3,772 $ 3,831 Service and repair fees - net 2,050 1,988 Scanning and management fees - net 14,878 7,229 -------- -------- Total Revenues - Net 20,700 13,048 -------- -------- COSTS AND EXPENSES: Cost of product sales 5,549 6,126 Cost of service and repair fees 2,035 1,629 Cost of scanning and management fees - net 9,363 4,578 Research and development expenses 4,603 3,846 Selling, general and administrative expenses 8,534 9,060 Provision for bad debt 596 1,480 Compensatory element of stock issuances 834 325 Amortization of excess of cost over assets acquired 105 - -------- -------- Total Costs and Expenses 31,619 27,044 -------- -------- Loss From Operations (10,919) (13,996) Interest Expense ( 274) ( 231) Interest Income 2,934 286 Other income-principally gain on litigation awards 331 9,650 ------ ------- Income (loss) before provision for taxes and minority interest ( 7,928) ( 4,291) Provision for income taxes - - ------- ------- Income (loss) before minority interest ( 7,928) ( 4,291) Minority interest in net (income) loss of subsidiary and partnership ( 62) 153 ------- ------- NET INCOME (LOSS) $( 7,990) $( 4,138) ======= ======= Net Income (Loss) per share $(.13) $(.07) ====== ====== Weighted average number of shares outstanding 61,120 58,693 ====== ====== See accompanying notes to consolidated financial statements (unaudited).
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (000'S OMITTED) FOR THE NINE MONTHS ENDED MARCH 31, ----------------- 1998 1997 ------ ------ Cash Flows from Operating Activities Net Income (Loss) $( 7,990) $( 4,138) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Minority interest in net income (loss) 62 ( 153) Depreciation and amortization 1,991 1,305 Provision for losses on accounts and notes receivable and accounts receivable from affiliates 596 1,445 Compensatory and fee element of stock issuances 834 325 Stock issued in settlement of current liabilities 760 1,080 (Increase) decrease in operating assets, net: Receivable from litigation award 77,223 - Accounts and notes receivable ( 4,190) ( 1,410) Costs and estimated earnings in excess of billings on uncompleted contracts ( 298) ( 361) Inventories ( 647) ( 103) Prepaid expenses and other current assets 122 602 Other assets ( 477) ( 214) Receivables and advances to affiliates and related parties 1,038 389 Increase (decrease) in operating liabilities, net: Accounts payable and income taxes ( 1,661) ( 240) Other current liabilities ( 475) ( 1,153) Customer advances ( 461) ( 125) Billings in excess of costs and estimated earnings on uncompleted contracts ( 193) 17 Other liabilities ( 101) ( 30) ------ ------ Net cash provided by (used in) operating activities 66,133 ( 2,764) ------ ------ Cash Flows from Investing Activities: Purchases of property and equipment - net ( 3,023) ( 507) Cost of capitalized software development and patents ( 106) ( 337) Purchase of Central Health Care Mgmt Service, net of cash acquired ( 50) - Purchase of A&A Services Inc and affiliates, net of cash acquired ( 3,900) - ------ ------ Net cash used in investing activities ( 7,079) ( 844) ------ ------ See accompanying notes to consolidated financial statements (unaudited).
FONAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (000'S OMITTED) FOR THE NINE MONTHS ENDED MARCH 31, ----------------- 1998 1997 ------ ------ Cash Flows from Financing Activities: Distribution to minority interest ( 135) - Repayment of borrowings and capital lease obligations ( 472) ( 723) Repayment of notes receivable in connection with shares issued under stock option and bonus plans - net 454 7,501 ------ ------ Net cash provided by (used in) financing activities ( 153) 6,778 ------ ------ Increase (Decrease) in Cash 58,901 3,170 Cash at beginning of period 5,861 3,861 ------ ------ Cash at end of period $64,762 $ 7,031 ====== ====== See accompanying notes to consolidated financial statements (unaudited).
FONAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE NINE MONTHS ENDED MARCH 31, 1998 AND 1997 (UNAUDITED) NOTE 1 - GENERAL Since its incorporation in 1978, FONAR Corporation and Subsidiaries ("the Company") has engaged in the research, development, production and marketing of medical scanning equipment which uses principles of Magnetic Resonance Imaging ("MRI") for the detection and diagnosis of human diseases. In addition to deriving revenues from the direct sale of MRI equipment, revenue is also generated from its installed base of customers through its service and upgrade programs. U.S. Health Management Corporation (Physician Practice Management Business) --------------------------------------------------------------------------- U.S. Health Management Corporation ("HMC") was organized by the Company in March 1997 as a wholly-owned subsidiary for the purpose of engaging in the business of providing comprehensive management services to physicians' practices and other medical providers, including diagnostic imaging centers and ancillary services. The services provided by the Company include development, administration, leasing of office space, facilities and medical equipment, provision of supplies, staffing and supervision of non-medical personnel, accounting, billing and collection and the development and implementation of practice growth and marketing strategies. This business is sometimes referred to as "physician practice management" (PPM"). HMC became actively engaged in the PPM business through two acquisitions which were consummated effective June 30, 1997. The acquired companies in both cases were actively engaged in the business of managing medical providers. With the exception of one multi-specialty practice, all of the medical providers are diagnostic imaging centers, principally MRI scanning centers. The first acquisition was of a group of several interrelated entities engaged in the business of managing three diagnostic imaging centers and one multi-speciality practice in New York State. The transaction was effected through a merger between a wholly-owned subsidiary of HMC and Affordable Diagnostics, Inc., one of the acquired companies which immediately prior to the merger had acquired the assets and assumed the liabilities of the other acquired companies (together, the "Affordable Companies"). The second completed acquisition was of Raymond V. Damadian, M.D. MR Scanning Centers Management Company ("RVDC"). Pursuant to the terms of the transaction, HMC purchased all of the issued and outstanding shares of stock of RVDC from Raymond V. Damadian in exchange for 10,000 shares of the common stock of FONAR. Raymond V. Damadian, the principal stockholder, President and Chairman of the Board of FONAR, was the sole stockholder, Director and President of RVDC immediately prior to the acquisitions. In connection with the acquisition of RVDC, HMC also acquired Tallahassee Magnetic Resonance Imaging, P.A. ("TMRI") and First Coast Magnetic Resonance Imaging, P.A. ("First Coast"), which also are wholly-owned by Raymond V. Damadian. The business of RVDC, acquired by HMC, was the management of MRI diagnostic imaging centers in New York, Florida, Georgia and other locations. As a result of the above described transactions, HMC has acquired the business of managing 24 MRI scanning centers. Twenty of the scanning centers are managed pursuant to management agreements, and four of the centers are partnerships, with RVDC as the general partner. Effective July 1, 1997, HMC entered into new management agreements with each of the centers. Pursuant to the management agreements, HMC is providing comprehensive management services, including administrative services, office facilities, office equipment, supplies and personnel (except for physicians) to the centers. Service for the centers' MRI scanning equipment is provided under the management agreements in these cases. MRI scanning systems are provided to thirteen of the centers pursuant to scanner leases entered into effective July 1, 1997. The accompanying unaudited condensed consolidated financial statements of Fonar Corporation and Subsidiaries ("the Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete consolidated financial statements. In the opinion of management, all adjustments (consisting of normal adjusting accruals) considered necessary for a fair presentation have been included. Operating results for the nine months ended March 31, 1998 are not necessarily indicative of the results that may be expected for the fiscal year ended June 30, 1998. The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto contained in the Company's Annual Report for the fiscal year ended June 30, 1997.
NOTE 2 - REVENUE RECOGNITION Revenue on sales contracts for scanners is recognized under the percentage-of-completion method. The Company manufactures its scanners under specific contracts that provide for progress payments. The percentage of completion is determined by the ratio of costs incurred to date on completed sub-assemblies to the total estimated cost for each scanner. Contract costs include material, direct labor and overhead. Provisions for estimated losses on uncompleted contracts, if any, are made in the period in which such losses are determined. The asset, "Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts", represents revenues recognized in excess of amounts billed. The liability, "Billings in Excess of Costs and Estimated Earnings on Uncompleted Contracts", represents billings in excess of revenues recognized. Revenue on scanner service contracts are recognized on the straight-line method over the related contract period, usually one year. Revenue from sales of other items are recognized upon shipment. Revenue under management contracts is recognized based upon contractual agreements for management services rendered by the Company under various long-term agreements with medical providers (the "PC's"), commencing July 1, 1997. The Company's agreements with the PC's stipulate fees for services rendered and are primarily calculated on activity based efforts at pre-determined rates per unit of activity. All fees are re-negotiable at the anniversary of the agreements and each year thereafter.
NOTE 3 - CASH AND CASH EQUIVALENTS On September 2, 1992, the Company filed an action against General Electric Company, ("GE"), Hitachi Ltd. and other defendants for patent infringements. On July 2, 1997, following the denial of GE's petition for a rehearing and application for a stay, GE paid the Company $128.7 million. After deductions of legal costs and expenses the net cash paid to the Company was $77.2 million. At March 31, 1998 cash and cash equivalents approximated $64.8 million of which $52.4 million was invested in two mutual funds. Approximately $12.3 million was invested in a short-term U.S. treasury fund and the $40.1 million as invested in a money market fund. The funds are managed by an affiliate company of major New York bank. Accordingly, the Company's cash and cash equivalents exceeded Federal Depository Insurance Corporation ("FDIC") and Securities Investors Protection Corporation ("SIPIC") limits by $63.5 million in the aggregate as of March 31, 1998. NOTE 4 - INVENTORIES The components of inventory consist of: (000's OMITTED) ---------------- March 31, 1998 June 30, 1997 ------- ------- Purchased parts components and supplies $ 3,011 $ 2,534 Work in progress 1,077 907 ------- ------- $ 4,088 $ 3,441 ======= =======
NOTE 5 - ACQUISITIONS Affordable Diagnostics, Inc. ---------------------------- On June 30, 1997, HMC acquired the assets, liabilities and operations of Affordable Diagnostics, Inc. ("Affordable"), a New York corporation, which managed and operated three diagnostic imaging centers and managed one multi-specialty practice in the Bronx, Westchester and New York. The acquisition was consummated pursuant to a Merger Agreement ("Agreement") effective June 30, 1997, by and between HMC's wholly-owned subsidiary, HMCM, Inc. ("HMCM") and Affordable. Pursuant to the agreement, HMCM acquired all of the assets and liabilities of Affordable in exchange for 1,764,000 shares of Fonar Common Stock, valued at $3,630,312. The merger was accounted for as a purchase, under which the purchase price was allocated to the acquired assets and assumed liabilities based upon fair values at the date of the merger. The excess of the purchase price over the fair value of the net assets acquired amounted to approximately $2,796,000 and is being amortized on a straight-line basis over 20 years. Subject to the centers achieving certain earning objectives within the next one year, an additional 576,000 shares may be issued to the sellers. These shares have not been included in the allocated purchase price because of the contingent nature of the arrangement. NOTE 5 - ACQUISITIONS (continued) Raymond V. Damadian M.D. MR Scanning Centers Management Company --------------------------------------------------------------- Effective June 30,1997, FONAR's wholly-owned subsidiary, U.S. Health Management Corporation ("HMC"),acquired RVDC by purchasing all of the issued and outstanding shares of RVDC from Dr. Damadian for 10,000 shares of the common stock of FONAR. In connection with the acquisition of RVDC, HMC also acquired a center in Tallahassee and Jacksonville, Florida. These transactions have been accounted for under the pooling of interests method of accounting. The business acquired include the management of twenty-one (21) MRI diagnostic centers located in New York, Florida and Georgia. Central Health Care Management Service, LLC ------------------------------------------- On January 23, 1998, a wholly-owned subsidiary of HMC acquired the business and assets of Central Health Care Management Services, LLC, a management service organization "MSO" operating in Westchester County, New York. The purchase price is to be determined in the future based on a multiple of the net positive cash flow from the acquired business over the succeeding twelve month period. The purchase price, when determined, is payable 1/3 in cash or marketable securities, 1/3 in notes and 1/3 in shares of common stock of Fonar or HMC. An advance of $50,000 was remitted to the seller at the closing date. Based on current financial data, the purchase price is expected to range from $660,000 to $1,100,000. Acquisition of A&A Services, Inc -------------------------------- On March 20, 1998, the Company's physician management subsidiary, HMC, consummated the acquisition of the common stock of A&A Services, Inc. ("A&A"), a New York corporation, which manages four primary care practices in Queens, New York. Pursuant to the A&A agreements, HMC acquired all of the common stock of A&A for $4,000,000 in cash, a note payable for $4,000,000 bearing interest at 6.0% per annum, payable in 16 quarterly installments commencing June of 1999, a note payable for $1,293,000 bearing interest at 6.0% per annum payable in 60 equal monthly installments of principal and interest commencing April 20, 1998, a deferred payment obligation of $2,000,000 and a contingent payment based on the acquired operations achieving certain earnings objective over the five-year period following the acquisition date. The promissory notes are collateralized by all of the assets of the acquired operations and are guaranteed by the Company. The deferred payment obligation of $2,000,000 is automatically convertible into shares of HMC's common stock upon the effectiveness of an initial public offering ("IPO") of HMC's securities, which is completed by September 20, 2000. In the event an IPO of HMC's securities is not completed by such date, the deferred payment obligation of $2,000,000 is then payable over the following four years with interest at 6.0% per annum. At such time when the deferred payment obligation is converted into shares of HMC's common stock, the holders of such shares will then have price guarantees from FONAR for a certain period following such conversions. The acquisition was accounted for as a purchase, under which the purchase price was allocated to the acquired assets and assumed liabilities based upon fair values at the date of the acquisition. The excess of the purchase price over the fair value of the net assets acquired amounted to approximately $10,953,000 and is being amortized on a straight-line basis over 30 years. The accompanying consolidated financial statements include the operations of A&A from the date of the acquisition.
NOTE 6 - SEGMENT INFORMATION The Company operates in two industry segments - manufacturing and the servicing of medical equipment and management of physician practices, including diagnostic imaging services. The following table shows in thousands of dollars net revenues, operating income and other financial information by industry segment for the nine months ended March 31, 1998 and 1997: 1998 1997 Net revenues: ------- ------- Medical equipment $ 5,822 $ 5,819 Physician practice management 14,878 7,229 ------- ------- Total $ 20,700 $ 13,048 ======= ======= Income (loss) from operations: Medical equipment $ (12,996) $(15,101) Physician practice management 2,077 1,105 ------- ------- Total $ (10,919) $(13,996) ======= ======= Depreciation and amortization: Medical equipment $ 978 $ 1,141 Physician practice management 1,013 164 ------- ------- Total $ 1,991 $ 1,305 ======= ======= Capital expenditures: Medical equipment $ 1,643 $ 680 Physician practice management 1,486 164 ------- ------- Total $ 3,129 $ 844 ======= ======= At At March 31, June 30, 1998 1997 ----------- -------- Identifiable assets: Medical equipment $ 78,547 $ 96,624 Physician practice management 26,310 10,067 ------- ------- Total $ 104,857 $106,691 ======= =======
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS. For the nine month period ended March 31, 1998, the Company reported a net loss of $7.99 million on revenues of $20.70 million as compared to a loss of $4.14 million on revenues of $13.05 million for the nine month period ended March 31, 1997. This represents a 58.62% increase in revenues from the comparable period for the prior fiscal year, reflecting the acquisitions consummated by the Company's subsidiary, U.S. Health Management Corporation. The smaller net loss in fiscal 1997 was attributable principally to proceeds received from the settlement of one of the Company's patent lawsuits. Results of operations, however, improved in fiscal 1998, from an operating loss of $14.00 million for the nine month period ended March 31, 1997 to an operating loss of $10.92 million for the nine month period ended March 31, 1998. For the fiscal quarter ended March 31, 1998 (third quarter of fiscal 1998), the Company reported a net loss of $3.67 million on revenues of $7.14 million as compared to a net loss of $5.57 million on revenues of $4.44 million for the third quarter of fiscal 1997. Operating results also improved from an operating loss of $5.64 million for the third quarter of fiscal 1997 to an operating loss of $4.38 million for the third quarter of fiscal 1998. The Company operates in two industry segments: the manufacture and servicing of medical (MRI) equipment, the Company's traditional business which is conducted directly by Fonar and physician practice management, a new line of business for the Company, which is conducted through Fonar's wholly-owned subsidiary, U.S. Health Management Corporation ("HMC"). HMC showed operating income of approximately $2.1 million ($3.0 million prior to merger related expenses and amortization of goodwill) for the first nine months of fiscal 1998 compared to operating income of $1.1 million for the first nine months of fiscal 1997. This reflected the profitability of HMC's three acquisitions, Central Health Care Management Services, LLC ("Central Health"), Affordable Diagnostics, Inc. and its related companies ("Affordable") and Raymond V. Damadian, M.D. MR Scanning Centers Management Company and two related Florida companies ("RVDC"). Central Health and Affordable were engaged in the business of providing management services, office space, equipment and non-medical personnel to health care providers and imaging facilities in the Bronx and Westchester Counties, New York. RVDC was engaged in the business of providing management and other services to 21 diagnostic imaging centers. Following the acquisition of RVDC, HMC increased the level of services rendered and the management fees charged to the imaging centers formerly managed by RVDC and integrated the operations of the acquired entities; HMC now provides centralized management, administrative, billing and other services to the various facilities from HMC's headquarters in Melville, New York. Notwithstanding an improvement in the operations of the Company's traditional MRI equipment manufacturing and services business ($13.0 million for the first nine months of fiscal 1998 as compared to $15.1 million for fiscal 1997), the income from operations attributable to HMC (physician practice management) was not sufficient to offset the operating loss from the Company's equipment manufacturing and service operations. Accordingly the Company's consolidated operating loss was $10.9 million for the first nine months of fiscal 1998 as compared to a consolidated operating loss of $14.0 million for the first nine months of fiscal 1997. The Company's operating loss was offset in part, however, by interest income of approximately $2.9 million (as compared to interest income of $286,000 for the first nine months of fiscal 1997). Interest income was derived from the interest earned on the Company's cash deposits and cash equivalents, which were approximately $64.8 million as at March 31, 1998. These amounts include the net proceeds of $77.2 million received by the Company in July 1997 from its patent lawsuit against General Electric Company. Approximately $52.4 million as of March 31, 1998 was held in mutual funds divided between a money market fund (76.53%) and a short-term U.S. Treasury fund (23.47%). The principal reason for the Company's operating losses is low product sales volumes. Sales revenues attributable to the Company's medical (MRI) equipment business (sales and service) were approximately $5.8 million for the first nine months of both fiscal 1998 and fiscal 1997 (against costs of revenues attributable to the Company's medical equipment business of approximately $7.6 million for the first nine months of fiscal 1998 and $7.8 million for the first nine months of fiscal 1997). The Company's efforts to improve equipment sales volume is focused on research and development ($4.6 million for the first nine months of fiscal 1998 as compared to $3.8 million for the first nine months of fiscal 1997) to improve the competitiveness of its products and increasing marketing and sales efforts. The Company's QUAD (TM) 7000 and QUAD (TM) 12000 MRI scanners, together with other research and development projects, are intended to significantly improve the Company's competitive position. The QUAD scanners are totally new non-claustrophobic scanners not previously available in the MRI market. At .6 Tesla field strength, the QUAD 12000 magnet is the highest field "Open MRI" in the industry, offering non-claustrophobic MRI together with high-field image quality for the first time. The Company expects marked demand for its high-field "Open MRI" scanners since image quality increases as a direct proportion to magnetic field strength. In addition, the Company's new scanners provide improved image quality and high speed imaging at costs that are significantly less than the competition and more in keeping with the medical cost reduction demands being made by our national leaders on behalf of the public. In addition to the QUAD scanners, the Company is completing the development of two new MRI scanners which are intended to enhance the Company's competitive position and revenues. At the MRI industry's annual trade show, RSNA (Radiological Society of North America), in November 1997, the Company introduced a new model scanner, the OR 360, one of its latest works-in-progress. Most of the design work for the OR 360 has been completed and construction of a prototype is approximately 60% complete. The Company expects to complete development of the OR 360 and apply for FDA approval by October, 1998. The Company estimates the approval process would take approximately three months. The OR 360 has an enlarged room sized magnet. Consequently, surgical teams may perform conventional surgery on the patient inside the magnet. Most importantly the surgeon can obtain the MRI image in real time during surgery to guide him in the surgery. Thus surgical instruments could be introduced directly into the body and guided to the malignant lesion by the MRI image. The number of inoperable lesions should be greatly reduced by the availability of this new capability. With current cancer treatment methods, therapy must always be restricted in the doses that can be applied to the malignant tissue because of the adverse effects on the healthy tissues. The Company expects that once its new OR 360 product is available, treatment agents may be administered directly to the malignant tissue through small catheters or needles. This would allow much larger doses of chemotherapy, x-rays, laser ablation, microwave, or rf to be applied directly and exclusively to the malignant tissue with more effective results. The presence of the MRI image during treatment will help the operator to judge during treatment if the treatment is being effective. The Company's other principal work in progress is a breast MRI scanner. MRI is dramatically superior to the present x-ray technology used in mammograms. MRI takes advantage of the nuclear resonance signal elicited from the body's tissues and the exceptional sensitivity of this signal for detecting disease. Consequently, the MRI image contrasts between healthy and cancerous soft tissue are high. In x-ray mammography, however, the x-ray image contrast between cancerous and healthy tissue is poor, making the detection of breast cancers by the x-ray mammogram less than optimal. An added benefit of MRI mammography relative to x-ray mammography is the elimination of the need for the patient to disrobe and the painful compression of the breast typical of the x-ray mammogram. The patient is scanned in her street clothes in MRI mammography. Moreover MRI mammogram scans the entire chest wall including the axilla for the presence of nodes which the x-ray mammogram cannot reach. A prototype of the Company's breast scanner has been constructed and the breast scanner is awaiting clinical trials. Clinical evaluation is expected to be completed within 16 months, and sales are expected to commence thereafter. It should be noted that the comparative figures in the Company's Consolidated Statements of Operations for the first nine months and third quarter of fiscal 1997 include the results of operations of RVDC but do not include the results of operations for Affordable or Central Health. The Company's Consolidated Statements of Operations for the first nine months and third quarter of fiscal 1998 include the results of operations of all three, as a result of the consummation of the acquisitions by HMC of Central Health, Affordable and RVDC. With respect to the revenues attributable to the Company's physician practice management business, the difference between the $14.9 million in revenues for the first nine months of fiscal 1998 and $7.2 million in revenues for the first nine months of fiscal 1997 reflects approximately $4.2 million in revenues attributable to Affordable, approximately $293,000 in revenues attributable to Central Health and approximately $3.2 million in revenues attributable to increased management fees charged by HMC to facilities formerly managed by RVDC. The difference between cost of revenues for the Company's physician practice management business of $9.3 million for the first nine months of fiscal 1998 and $4.6 million for the first nine months of fiscal 1997 is attributable to Affordable's costs of revenues of approximately $2.2 million, Central Health's costs of revenue of $123,000 and additional costs of approximately $2.4 million incurred to provide increased levels of service to facilities formerly managed by RVDC. The Company has continued its efforts to increase scanner sales in foreign countries as well as domestically. Revenues from foreign product sales were $1,177,825 (approximately 31% of product sales revenues and 6% of all revenues) for the first nine months of fiscal 1998, against costs of revenues for such sales of $1.5 million (approximately 27% of costs of revenues for product sales and 9% of all costs of revenues). This compares to $457,658 in foreign product sales revenues in the first nine months of fiscal 1997 (approximately 12% of product sales revenues and 4% of all revenues) against $733,539 in costs of foreign product sales revenues (approximately 12% of costs of revenues for product sales and 6% of all costs of revenues) for the first nine months of fiscal 1997. Liquidity and Capital Resources At March 31, 1998, the Company's liquidity and capital resources positions changed from its June 30, 1997 position as follows: March 31, June 30, 1998 1997 Change ____________ ____________ __________ Working capital surplus $54,097,000 $62,659,000 ($8,562,000) The decrease in working capital since June 30, 1997 was attributable to the Company's losses in the first nine months of fiscal 1998. Total liabilities were increased since June 30, 1997 by approximately $2.6 million to approximately $35.8 million at March 31, 1998. As of March 31, 1998, the Company had no unused credit facilities with banks or financial institutions. The Company's business plan currently includes an aggressive program for manufacturing and selling its new line of QUAD scanners and expanding its new physician practice management business. The Company believes that it has sufficient cash resources to support its operations, including new product development. The Company estimates completion of the development of its new OR 360 and breast scanners will require approximately $4,000,000 and $2,000,000 respectively.
PART II - OTHER INFORMATION Item 1 - Legal Proceedings: In June 1995 a Fonar stockholder commenced an action in the Delaware Court of Chancery against Fonar and its directors, alleging breaches of fiduciary duties by the defendants in connection with a recapitalization plan adopted by the stockholders of the Company on April 3, 1995 (Horace Rubenstein, Individually and on Behalf of All Others Similarly Situated v. Raymond V. Damadian et al., C.A. No. 14378). The case was settled in April 1997. Under the original terms of the settlement agreement, as approved by the Court of Chancery on April 29, 1997, the Company, among other things, agreed to issue Warrants to purchase Common Stock to the holders of Fonar Common Stock as of October 20, 1995. On December 17, 1997, counsel for the Plaintiff (Class) and the Company reached an agreement to amend the settlement agreement. On March 2, 1998, the Court of Chancery approved the modification. The modification provides that the Company issue 2,231,689.6 shares of Fonar Common Stock in substitution for the 4,909,767 Warrants that were to have been issued. These shares were issued in April 1998. In addition, the modification provides for a schedule to pay the special dividends on the Company's Common Stock and Class A Non-voting Preferred Stock with respect to awards and settlements already received by the Company in connection with its patent litigations. The first installment of these dividends will be paid to holders of the Company's Class A Non-voting Preferred Stock and Common Stock as of May 15, 1998. The payment date will be May 26, 1998. Item 2 - Changes in Securities: None Item 3 - Defaults Upon Senior Securities: None Item 4 - Submission of Matters to a Vote of Security Holders: None Item 5 - Other Information: Acquisition of New Business Effective March 20, 1998, the Company's wholly-owned subsidiary, U.S. Health Management Corporation ("HMC") acquired 100% of the issued and outstanding stock of A & A Services, Inc. ("A & A Services"), a management services organization (MSO) engaged in the business of managing four primary care practices located in Queens County, New York (the "Practices"). A & A Services provides the Practices with management services, office space, equipment, repair and maintenance service for the equipment and clerical and other non-medical personnel. The office locations for the Practices are located in Woodhaven, Richmond Hill, Corona and Ridgewood in Queens County, New York. Item 6 - Exhibits and Reports on Form 8-K: Form 8-K filed on April 7, 1998 for acquisition of A & A Services, Inc. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FONAR CORPORATION (Registrant) By: /s/ Raymond V. Damadian Raymond V. Damadian President & Chairman Dated: May 15, 1998